Why Black Founders Continue To Not Be Funded in Silicon Valley
Silicon Valley, Now.
Silicon Valley’s lack of diversity has long been something that people have highlighted as well as worked on improving, but this has continued to be an issue. Venture capital firms have continued for decades to fund and elevate founders of the same background: white, male, computer science students from elite institutions like Stanford, MIT, and Harvard. The lack of racial diversity in this industry is incredibly apparent when you see that only around 1.2% of total venture capital funding in the US was raised by black founders in 202. This is easily reflected just by looking at the biggest startups of the past decade. From Mark Zuckerberg with Facebook to Evan Spiegel with Snapchat and Elon Musk with Tesla, the founders of some of the most successful startups come from a few select prestigious institutions like Harvard, Stanford, and the University of Pennsylvania and are all white.
However, this disparity in funding as well as the lack of diversity in startup founders has been frequently brought up as a problem people are focusing on solving. Business leaders like Daniel Applewhite have argued that “power and structural racism have crippled the startup ecosystem,” and black entrepreneurs recount their racist experiences with investors and point toward racial discrimination as the reason why they don’t receive funding. However, George Floyd’s tragic passing and the Black Lives Matter movement were a racial reckoning for Silicon Valley to focus even more on diversity to create tangible change. Since then, there has been an increase in the total funding for black founders in Silicon Valley as well as the number of black investors in venture capital (VC). Black founders raised $4.2 billion, or 1.2% of all 2021 venture capital funding, compared with $1.1 billion in 2020 which is .6% of that year’s total VC funding. However, even this increase in funding to Black founders represents a tiny fraction of the record $147 billion in VC invested in startups in U.S. startups in 2021. If you look at the broader context, as seen on the Crunchbase chart below, this is only a .1% increase from the previous record highest percentage of funding to black entrepreneurs which was 1.1% in 2017 and 2018. Given the increased focus on diversity efforts, it’s worth investigating why Black founders are still receiving significantly less funding than other demographic groups. While it might be true that racial biases contribute to a lack of funding, the explanation is more complicated. VC funds are going about solving this problem in the wrong way. Instead of creating small initiatives to fund black founders, they need to fix the structural problem of racial bias in their pattern matching of investments.
Why Current Solutions Don’t Actually Address the Real Problem
The tragic passing of George Floyd led the VC industry to double down on diversity through a variety of different solutions. Some started initiatives focusing on funding diverse founders as well as increasing representation in VC. Black representation in venture capital investors also rose from 3% in 2020 to 4% in 2021. Reach Captial, Harlem Capital, and MaC Ventures raised over 100 million dollars to fund diverse founders which is the first time black-founded VC funds have accomplished that. These were all attempts from newcomers and industry veterans trying to fix the problem of black founders only receiving a small sliver of overall venture funding.
Softbank is an example of how small diversity initiatives will never make the type of change that real structural change would. In June 2020, Softbank’s created a 100 million dollar opportunity fund that only invests in minority founders which at its time was the biggest fund ever dedicated to funding diverse founders. Marcelo Claure, COO of Softbank, stated that this initiative was started because, “he wanted to start a fund solely dedicated to entrepreneurs of color, to give them not only the same opportunity but a better opportunity because it will be fully dedicated to them.” This fund is co-led by Claure and run by a dedicated and diverse team separate from the rest of Softbank’s VC fund. However, Softbank’s primary investment fund is the their100 billion-dollar vision fund – the opportunity fund is only 0.1% of Softbank’s larger vision fund. In Softbank’s larger vision fund, only one investment out of 88 that they have done has been to a black founder: Robert Riffkan who is the founder of Compass. These facts and figures show the glaring problem that these current solutions aren’t enough. It may look like these venture capital funds are pioneering huge initiatives and solving this long-standing problem of fundraising disparity since last year’s percentage of funding for black founders increased, but the broader context shows that these solutions are at best, band-aid solutions to the larger issue. A 100 million dollar fund for only black entrepreneurs is groundbreaking on paper but doesn’t actually do much to move the needle forward for black founders to receive more funding. These initiatives are an attempt to address racial bias as the reason for black startup founders not being funded by creating opportunities for only minorities. The actual root of the problem is that investors are not funding and considering minority founders for their usually much larger, general investments.
Racism is Silicon Valley and Its Effects
Racism has been prevalent in Silicon Valley which has huge consequences on black founders receiving less funding since the people deploying funding affect who receives it. The world of venture capital has always been exclusive since only a select few have control over so much capital. Just a quick look at most team pages on different firms would see that most people in positions of power are white old men (RomburghGené). This lack of representation on the investor side is important to note because research has shown that investors are more likely to back founders that have the same ethnic background as them. Not only with just funding, but they are also more likely to be on the board of these startups, personally invest their own money, and go above and beyond to help. The findings from Bengtsson, Ola, and Hsu reveal how biases can have further consequences on who actually gets the funding.
However, racial bias doesn’t explain everything because the numerous initiatives focusing on increasing funding opportunities and representation have done little to increase the percentage of black founders being funded. The Black Lives Matter movement was a catalyst for Silicon Valley to focus on diversity. This has created an environment where now more than ever, venture capital investors are challenged to put diversity at the forefront not only in funding startups but in the actual makeup of investors as well. In 2021, there was an all-time high of venture capital funds owned by majority ethnic minorities coming up to be at least 627 firms, making it a 25% increase from the year before. It’s not to say that bias still doesn’t exist because of these improvements, but this argument of internal bias being the main problem doesn’t hold up anymore with diversity being top of mind for the entire industry.
The public has begun to hold these institutions accountable for their actions and has put enormous pressure on firms to follow through on the promises made, but many venture capital firms have failed to actually create change and follow through. One of the latest examples of that is how Bain Capital released a public statement apologizing for the lack of gender and racial diversity on their team. It’s no longer the same environment it was pre-2020 where diversity was only ever talked about, but there was never a huge public outrage for Silicon Valley power players neglecting this. Even after the public apology, Bain Capital as of now still hasn’t added any new investors to its team. These actions don’t reflect Bain Captial’s statement in 2020 where they promised to “provide more than $100 million over the next decade to nonprofits focused on racial equality and similar issues.” This further drives home my point of how the initiatives and statements about diversity during the Black Lives Matter movement aren’t reflected in their current actions.
Pattern Matching Can’t Be Solved by Diversity Initiatives
Pattern matching in investing has created a huge disparity for black founders because it favors founders from a certain background which oftentimes excludes the majority of black founders since they don’t fit into those parameters. Pattern matching is also known as pattern recognition. According to Ben Horrowitz who is the co-founder and managing director of one of best performing VC funds (A16z), pattern matching came from “experienced VCs having been on dozens of boards and seen thousands of deals. As a result, they recognize patterns of strategy and behavior that generally work and patterns that generally fail” (Horrowitz). Many funds, including A16z, have publicly stated that they use pattern matching to identify potentially successful startups.” The reason for this is that many venture capital firms become leaders and successful in the industry through having a track record of successful investments. Investors rely on what they’ve seen to “work” in the past as an anchor for their future investment decisions. Their typical approach is to evaluate a company and gain a frame of reference through all the other deals they’ve already seen. This leads to many assumptions being made about the startup and founders because they view everything through what they have seen previously.
VC investors’ pattern match because it gives them a clear framework to invest through, but this entrenched system ignores the thousands of amazing black founders just because they don’t check off specific boxes. Investors look at hundreds if not thousands of companies every year, but only invest anywhere from as little as below 10 at smaller firms to over a hundred at bigger firms. Pattern matching was developed as a way for the process to be more efficient (Greathouse). Greathouse talks about how investors “adopt efficient methods of quickly assessing if a person/opportunity is worth further diligence.” From initial screenings of investments to being deep in the diligence process after weeks/months of conversations, Investors pattern-match through every step of the process. This is because, without this framework, there would be overwhelming amounts of information and any way to systematically go through all the startups they see. Pattern matching essentially is a filter, a contrived list of criteria. The assumption is that by relying on their experience with funding successful founders in the past, pattern matching would allow investors to efficiently identify their next successful startup. This would be done by just finding other founders with the same or similar characteristics to successful startup founders they’ve backed previously. But the problem with the framework of pattern matching is that the most successful startup in past like Facebook, Twitter, Snapchat, Airbnb, Uber, and Apple have all been founded by white men. None of these tech giants that have given their investors their reputation and outsized returns were from black founders. This is where you see that if investors are mostly basing current investment decisions on their past successes, they probably wouldn’t fund black entrepreneurs because they don’t fit into the backgrounds of successful founders they’ve funded.
The closed-off nature of Silicon Valley has bred a system based on nepotism and elitism which continues to uplift founders of a certain background while excluding others. The people in the industry who are in positions of power were wealthy old white men from elite institutions. This created an environment where most of the investments investors end up making are actually from their own personal networks, all of which are similar in background to them. Sequoia partner Mike Moritz describes how “ a lot of the investments that have come our way, a friend of a friend talked to us about it, and told us about it, and encouraged the founder and the CEO to come and chat with us.” Many of the early successful startups like Facebook were funded because of these networks. While the venture industry is less closed off compared to decades ago, Silicon Valley’s start has pro-longed consequences. Because the early successful startups were funded through these investor networks, venture capital funds are pattern-matching these past investments. This is why they continue to fund white male founders from elite institutions, and this disparity of funding for black entrepreneurs persists because they just aren’t in these networks and rarely have the same characteristics as these investors.
How the Pipeline Problem Exacerbates The Problems Caused by Pattern Matching
There aren’t as many black founders being funded because the elite institutions that venture capital firms focus on investing out of don’t have many black students. According to Crunchbase, the top five universities with the most amount of graduated startup founders who have received funding from investors are Stanford, MIT, Harvard, UC Berkley, and Cornell (Glasner). A common trend when looking at all of the institutions on the list is that they all have strong computer science and STEM departments. This is because most investors focus on funding founders who are technical which makes the pool of people who are likely to get funded even smaller. In 2018, only 8% of all students who graduate with a bachelor’s in CS are black (NCES). Because these are the traits and places investors focus on investing from, this reveals a fundamental pipeline problem because there just aren’t that many black founders who have computer science degrees from an elite institutions.
Investors’ reliance on pattern-matching investments creates a cycle where black founders will continue to be excluded because there aren’t as many of them at these elite institutions. If investors continue to rely on pattern matching to invest, the funding for black founders will not increase. Their reliance on this strategy to gain investments has built a system that uplifts these privileged networks while keeping out promising black entrepreneurs who don’t fit into the backgrounds they’re looking for. This system starts with investors investing only in schools from prestigious institutions like Stanford. Then, if Stanford founders become successful, they naturally give back to their alma mater and help improve their institutions’ entrepreneurship scene. Because of pattern matching, investors continue to fund startups from the same institutions their most successful founders are from and the cycle continues to repeat which has led to colleges like Stanford and Harvard becoming so prominent.
In conclusion, venture capital funding for black startup founders is significantly less because VCs subscribe to pattern matching which is why they invest from certain backgrounds. This background is white male founders who have computer science degrees from elite institutions. As long as investors’ pattern match, this disparity will continue because none of the diversity initiatives prominent venture capital funds have started actually focusing on fixing this issue. Instead, all of them continue to use band-aid solutions to cover up the elitism that’s entrenched in this industry. The real solution to this problem would be for investors to fix their general investment practices to be more diverse, and not only commit to focusing on diversity for smaller initiatives. If venture capital funds can break out of the culture of exclusion that pattern matching has created, they would begin to see (and invest in) the ground-breaking startups that black founders are building, with or without their support.
As a college student, I don’t have the influence to change Silicon Valley from the top down for it to become more diverse. However, I’ve put together a database of venture capital in my network and I’d be happy to connect any founders (but especially ones from traditionally marginalized groups) too. I also have a job board of startups in my network who are actively hiring. If we all make small changes like making an introduction, we can slowly change the industry.